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Roth Conversion

Pay taxes now? Pay taxes later? This summarizes the key difference between a Roth IRA and a Traditional IRA. But until recently, the choice between IRA “flavors” didn’t exist for many taxpayers. Which one is right for you? Ask an Old Second Wealth Management Retirement Solutions expert. They would be happy to walk you through the analysis to see which choice would likely be the most beneficial to your circumstances.

What has changed?

While annual income restrictions will still keep many taxpayers from being able to make new contributions to Roth IRAs, taxpayers are no longer prevented from converting their Traditional IRAs into Roth IRAs. Previous income restrictions on conversions have been permanently lifted.

New regulations now allow anyone to convert all or a portion of their Traditional IRAs into a Roth IRA…at any time, regardless of their household income level. But converting isn’t necessarily the right choice for everyone. At Old Second, our Wealth Management Retirement Solutions experts can help you weigh the pros and cons and choose the retirement plan option that will be best for you.

Roth IRA vs. Traditional IRA

Deciding when you want to pay taxes on your IRA savings is the essential difference between a Roth IRA and a Traditional IRA. With a Traditional IRA, the tax benefit is received upfront—qualifying contributions are made before taxes. This can lower an individual’s tax bill in the year the contribution is made. But when distributions begin in retirement, withdrawals are taxed as ordinary income.

With a Roth IRA, contributions are made after taxes are paid—that includes amounts being converted into a Roth IRA. But withdrawals in retirement occur free of additional taxation, provided the Roth IRA has been open at least five years.

In other words, unlike Traditional IRAs, which allow you to grow assets for retirement on a tax-deferred basis, qualified Roth IRAs allow you to grow assets on a tax-free basis.

Other key benefits of Roth IRAs:

  • Roth IRAs are not subject to mandatory distribution rules. With traditional IRAs, distributions must begin by the age of 70 ½.
  • The assets in Roth IRAs may be passed on to heirs without taxes being incurred. This can make them valuable estate planning tools for many investors.

Why would you convert to a Roth IRA?

For many taxpayers, an IRA conversion could be attractive if:

  • You are concerned you will be in a higher tax bracket in retirement than you are in now.
  • You believe that the general level of income tax rates will be higher in retirement than they are today.
  • You can pay the taxes that will arise from converting without dipping into your IRA balance.
  • You doubt you will need the money in your IRA account and would like to transfer it to your heirs free of taxes.
  • You won’t need the money in the converted Roth IRA for at least 5 years.

Why wouldn’t you convert?

For many taxpayers, an IRA conversion would not be attractive if:

  • You expect to be in a lower tax bracket in retirement than you are in now.
  • You are unable to pay the taxes incurred on conversion with cash rather than money in your IRA.
  • You think you might need to access the money held in the IRA in less than 5 years

What you need to know about converting in 2010

Prior to January 1, 2010, only those with modified adjusted gross incomes of $100,000 or less were able to convert Traditional IRAs to Roth IRAs. That restriction no longer applies. Now, any taxpayer, regardless of income, can convert to a Roth IRA—though income restrictions on new contributions to a Roth IRA still apply.

To provide an incentive to convert in 2010, the IRS will allow the resulting tax liability to be spread over two years—2011 and 2012—with no taxes actually due on the conversion in 2010. Roth conversions occurring in subsequent years will still be available to anyone regardless of income, but all of the taxes incurred on the conversion will be due in the year the conversion takes place.